[This article has been written by Sandeep Parekh, Managing Partner, Finsec Law Advisors, and published in Financial Express on November 28, 2017]
The greatest philosopher, who almost no one has read, Immanuel Kant, spoke about the categorical or moral imperative. He discussed the imperative as a principle of reason, which was an unconditional obligation to do the right thing regardless of our will or desires. The insolvency ordinance should also be seen from this perspective, ignoring a strictly economic explanation of the best financial outcome. In summary, the government brought out an ordinance which would debar promoters or rather former promoters from becoming buyers of their erstwhile company. In its own words, the government’s objective is “to keep-out such persons who have wilfully defaulted, are associated with non-performing assets, or are habitually non-compliant and, therefore, are likely to be a risk to successful resolution of insolvency of a company” and “to impose restrictions for such persons to participate in the resolution or liquidation process.”
In brief, the ordinance bars wilful defaulters, undischarged insolvents, persons convicted of an offence with over two-year imprisonment, individuals disqualified as directors under the Companies Act, persons banned by SEBI from securities market and persons banned under insolvency law for fraudulent activities. It also bars a person who executed enforceable guarantee in favour of a creditor in respect of an insolvent entity and promoters or sister concerns of companies with non-performing assets of more than one year. While few can quarrel with the first list even though the concept of wilful defaulter is not well-articulated by the central bank, it is the second list that has caused controversy. Should failed promoters be ineligible to purchase shares of the company they sank, however innocently? Should guarantors who guaranteed loan repayment be debarred from bidding for bad assets?
To give the context, we have lived in a decade where outrageous loans were made. While at it, both lenders and borrowers enjoyed the Omerta Code of keeping defaults very private. At help was a section of the RBI Act that seemed to support the dark web where the public was kept in the dark about the stratospheric debt of companies most of us had not even heard of. Clearly, RBI has not heard of the Right to Information Act. How many of us know that Bhushan Steel had a debt of Rs. 50,000 crore? Many loans were clearly crony capitalism at play. Many were just poor investment decisions in industries which bled because of macroeconomic conditions or global pricing pressures or even domestic competitiveness issues. With a decade since many were made, it is difficult to figure which ones were the crony offerings and which ones were genuine business failures.
In a court of law, this would be a near-impossible hypothesis to prove, whether or not, in a given case, bribes or other benefits were the cause of the loans. Even in the event of business failures, there is very little cause for letting the rot set so deep that hardly anything is salvageable in many of these companies. Imagine you or me getting a car loan which, after three years, is ten times the value of the car. It wouldn’t happen, so why did it happen when there were many more zeros involved and the degree of scrutiny ought to have been higher? Genuine business failure is no justification for being asleep on the wheel so long that the value of the loan exceeds the value of the asset by many times. It was almost as if the lenders thought that, by efflux of time, the rust will vanish.
This experience is so different from your and my experiences as borrowers. Not only would we not get more than the value of the car or house, but in the case of a depreciating asset, the cover would always comfortably exceed the due as on that date. Add to this, no one’s experience on a debt forgiveness of even a single rupee by a single month for our personal loans, and add to that the potent cocktail of justifiable outrage that it wasn’t bankers’ money that has been used to bail out such companies through haircuts. It was taxpayers’ money directly and depositors’ money indirectly, in terms of lower deposit rates on savings accounts. Contrary to what economists have convinced us, we live in a society rather than in an economy. And individual and societal outrage at this loss is both necessary and justified.
Yes, commentators have seen this from an economic lens and have argued against the introduction of a restriction on grounds of economic efficiency. Yes, the ordinance is a blunt tool. Yes, it will have the unintended effect of reduced salvage value. Yes, it will be challenged, like all laws which have a big financial impact. Yes, it will be unfair to some promoters who have failed, but want a second chance, while at the same time offering the most money to bankers and lenders. But seen from a moral or political lens, the ordinance makes a lot of sense. People’s sense of unfairness at fat cats buying houses abroad while their companies default in India needed to be resolved.
Similarly, going forward, the moral hazard of taxpayers paying the bills of failed or corrupt businessmen will reduce. And companies which needed to be laid to rest will finally be laid into the crematorium and the endless wait for the rust to vanish on its own, monsoon after monsoon, will also go away. Failing companies will be resolved within a year of the downslide, minimising the damage to lenders and equity shareholders alike. As a good entrepreneur would tell us, failing often is not the key to success, but failing small and early might be. The ordinance, by cutting the rot early, will allow early but small failures, while penalising promoters who wait too long either in the hope of being bailed out or based on unreal hope. India will see a new age of businesses from the ashes of the dead and this creative destruction will make India more competitive.
Ultimately, we should not underestimate the power of creative destruction. As I read at a reserve forest which saw several forest fires each year, “the forces of creation are at least as powerful as those of destruction.” I am also hopeful that an unintended benefit of this whole process will be a wider-held shareholding taking root in India rather than the promoter-driven model. That can have significant upsides in terms of better and more professional governance of Indian companies which are larger and more competitive. Yes, your and my outrage has helped bring this ordinance and our continuing outrage should ensure that public loot and imprudent lending does not continue. At this stage, our moral thirst is more than our economic thirst. That is for the present. With the ordinance, expect behavioural changes so that both the moral and economic thirsts are quenched simultaneously in the future. What is good for a car loan should be good for industry loan as well.